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How to Financially Manage Your NSF Graduate Research Fellowship

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Congratulations on being awarded the National Science Foundation (NSF) Graduate Research Fellowship (GRF) (or a similar remunerative, competitive, national fellowship)! Whether you’re a prospective grad student or a current first- or second-year PhD student, this fellowship is a great boon to your research, your CV, and almost certainly your finances. However, you may not yet realize that your finances will become a bit tricky once you start receiving your fellowship. With the help of this article, you can avoid the pitfalls associated with fellowship income and fully capitalize on the benefits.

NSF GRFP stipend

Further listening: The Financial and Career Opportunities Available to National Science Foundation Graduate Research Fellows

The NSF GRFP’s Negotiation Power

I’m sure you didn’t miss this headline info about the NSF GRFP: The fellowship pays you a stipend of $34,000 plus $12,000 of educational expenses to your institution for three years. Awesome! At the majority of universities in the US, that stipend amount is well above what you would be paid if you didn’t receive the fellowship, so you’ve effectively achieved a raise for the next three years.

But the good news doesn’t stop there: Your university/department might confer even more benefits upon you for winning independent funding. If the administration isn’t forthcoming about these additional benefits, it is appropriate to inquire about them.

Independence

Your new outside funding may give you a degree of independence in your research that you wouldn’t otherwise enjoy. This is highly dependent on your field, department, and advisor, but the fellowship may enable you to take your doctoral research in a direction that you advisor couldn’t or wouldn’t have supported without it. Perhaps you could take a risk on a side project, establish a new collaboration, or take extra time to rotate through a lab to gain new skills.

Additional Funding

At many universities, there is a standard offer of additional funding for winning a multi-year, lucrative fellowship like the NSF. This offer could come in one or more forms, such as:

  • A guarantee of funding for additional years
  • A one-time bonus
  • A stipend supplement above $34,000 while you have the fellowship
  • A stipend supplement after the fellowship concludes (e.g., up to $34,000/year for your remaining time in graduate school)

Not all departments offer additional funding to NSF GRFP recipients, but it’s worth inquiring about with your advisor, the administration, and current NSF fellows at your university. Stipend supplements during the time that you receive the NSF GRF are more common in high cost-of-living cities where the departmental base stipend is near $34,000/year to begin with. For example, searching “NSF” in the PhD Stipends database reveals stipend supplements awarded during the NSF GRFP years to students at the University of California at Berkeley, Northwestern University, and Columbia University, while a student at the University of California at San Diego writes that he/she received no funding incentive for winning the NSF GRF.

For Prospective Graduate Students

You’ll never have more negotiation power than you do as a prospective graduate student with an outside fellowship in hand. Unfortunately, you don’t have a lot of time to negotiate as the NSF GRFP awards list comes out approximately two weeks before grad school decision day, April 15.

Further reading: Vote with Your Feet, Prospective Graduate Students

As quickly as possible, you need to clarify if the offers from the universities you are still considering are going to be sweetened at all now that you have your fellowship. If the financial package from your preferred university isn’t up to par with your other offers (after considering cost of living differences), you can tactfully ask if a bonus, stipend supplement, or guarantee of future funding is possible.

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Budgeting with Your Fellowship Income

There are two vital questions you need to ask of your department before you can begin creating a budget for your NSF GRF stipend.

  1. After the fellowship ends, what will my stipend be?
  2. How frequently is my fellowship disbursed?

Accelerate Progress on Financial Goals

In my ideal personal finance-oriented world, an NSF fellow would live on (less than) the base stipend from his department and put all the excess income received toward growing his wealth. There are a few advantages to that approach:

  • Your lifestyle roughly matches that of your peers in your department.
  • You can relatively quickly achieve financial goals such as saving or debt repayment.
  • If your income is set to drop once the fellowship ends, you avoid acclimation to the higher, temporary income and don’t have to make major lifestyle sacrifices once the three years are up.

Some financial goals you could work on during the time you receive the additional fellowship funds are:

  • Eliminating any troublesome debt (e.g., credit card balances, medical debt, car loan)
  • Saving up cash for short-term needs and expenses (e.g., emergency fund, targeted savings accounts)
  • Investing for long- and mid-term goals (e.g., retirement, house down payment)
  • Pay down student loans

Further reading:

This strategy is easiest to implement for graduate students who start the NSF GRF after one or more years in grad school. Just put all of your ‘raise’ toward financial goals and don’t change anything about your lifestyle! Prospective grad students will have to be more conscious about setting up their grad student lifestyle on a lower income than they will start out with.

Preparing for the Post-Fellowship Income Drop

If you choose to upgrade your lifestyle with your fellowship stipend, be careful to maintain any long-term financial contracts at a level that will be sustainable for you after your income drops (if it will). The two key areas to watch out for are housing and transportation expenses. While it is possible to reduce your spending in either of these areas during grad school, it is a painful process, so it is preferable to lock in your spending in those areas at a level that you can maintain long-term.

Budgeting with an Irregular Income

Sometimes, fellowships are disbursed to the recipient at a frequency other than monthly, e.g., once per term. This schedule can cause issues for budgeting, which is usually framed as turning over each month.

One of the advantages of an infrequent disbursement schedule is that you are paid at the beginning of the period rather than the end, so the money you need throughout the period is already available to you. However, you may not be able/inclined to use typical budgeting software functions and prefer to set up your own budgeting system.

One of the most useful budgeting concepts for people with irregular incomes is that of fixed vs. variable expenses. At the beginning of your budgeting period, project the fixed expenses that will be paid during the period, such as your rent/mortgage, debt payments, certain utilities, subscriptions, etc. Then allocate your remaining income to your variable expenses at a frequency that is convenient for you. For example, you can estimate the variable utility bills that you may pay monthly during the period, plan to spend no more than a certain amount of money each week on groceries, and give yourself a lump sum of money for entertainment for the entire period to be spent as opportunities arise. In this way, allocate your fellowship disbursement so that you are sure that your expenses won’t exceed your income (leaving some buffer for unexpected expenses).

Income Tax Implications of the NSF GRFP

Your NSF GRFP stipend is subject to federal income tax. (It is usually subject to state and local income tax as well, but there are some exceptions.)

Further reading:

However, the taxation of fellowship stipends is handled completely differently by universities than assistantship pay.

Tax Reporting

While assistantship pay is reported on a W-2, fellowship stipends are not required to be reported in any particular way.

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A large fraction of universities, possibly the majority, do not report outside fellowship stipends on any official tax form. At most, the fellow might receive a courtesy letter, which is an informal letter stating the amount of the fellowship stipend received during the calendar year.

Some universities report fellowship stipends on Form 1098-T in Box 5 (along with other scholarship and grant income).

A small minority of universities report fellowship stipends on Form 1099-MISC in Box 3.

Whatever reporting mechanism used or not used, the important information to bring to your tax return preparation process is the amount of fellowship stipend paid to you during the calendar year. From that point, the fellowship stipend income is treated the same as any other fellowship/scholarship/grant income, and (possibly after some adjustments) it will ultimately be taxed as ordinary income.

Further reading:

Quarterly Estimated Tax

While you are required to pay federal and usually state income tax on your fellowship stipend, the vast majority of universities do not offer automatic income tax withholding on your fellowship stipend as they normally do for employee pay. (You should inquire whether automatic withholding is an option and use it if so, but the remainder of this section assumes it is not offered.)

This means that you will receive 100% of your gross fellowship stipend instead of your stipend net of income tax as you would assistantship pay. However, the IRS still expects to receive income tax payments throughout the year, so you will have to look into filing quarterly estimated tax.

Further reading: The Complete Guide to Quarterly Estimated Tax for Fellowship Recipients

As a default position, you should assume you are responsible for paying quarterly estimated tax. It’s possible that you won’t be required to in the year you switch on or off of the fellowship or if you’re married to someone with a high income and high withholding, but even in those cases it’s prudent to check.

The way you calculate your quarterly estimated tax due (and figure out if it’s required of you) is by filling out Form 1040-ES. That form will give you the amount of the payment you are supposed to make four times per year and an estimate of your total tax due for the year. You can make the payment online at IRS.gov/payments or through a host of other mechanisms.

Whether or not you are required to file quarterly estimated tax, it’s a great idea to set up a personal system that simulates automatic tax withholding. Open a separate savings account labeled “Income Tax” and transfer in the fraction of each paycheck you receive that you ultimately expect to pay in tax each time you are paid. Then, draw from that savings account when you make your quarterly or yearly tax payments.

Investing Implications of the NSF GRFP

The upside of receiving the NSF GRF is that your income is most likely higher than it would have been, which means you have an increased ability to achieve financial goals during graduate school such as debt repayment, saving, and/or investing.

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Through 2019, fellowship income, like that of the GRFP, was not eligible to be contributed to an Individual Retirement Arrangement (IRA). However, starting with tax year 2020, fellowship income is eligible to be contributed to an IRA, eliminating the only major downside of receiving fellowship income.

Further listening: Fellowship Income Is Now Eligible to Be Contributed to an IRA!

An IRA is a tax-advantaged retirement savings vehicle. It’s a great idea to use an IRA (or other tax-advantaged retirement vehicle such as a 401(k) or 403(b)) for your retirement savings as it helps you maximize your long-term rate of return by protecting your investments from taxes. As a graduate student, you almost certainly don’t have access to the university 403(b), so the IRA is basically the only game in town for tax-advantaged retirement savings.

Further reading:

Making Ends Meet on a Graduate Student Stipend in Los Angeles

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In this episode, Emily interviews Adriana Sperlea, a PhD student in computational biology at the University of California at Los Angeles (UCLA). Living in Los Angeles is financially challenging to say the least, and Adriana has found ways to improve her cash flow over time, such as by doing a summer internship, moving into subsidized graduate housing, living car-free, and budgeting intensively. She has even recently started contributing to a Roth IRA! Adriana and Emily additionally discuss how Adriana discovered that she owed a large tax bill on her fellowship income and how she paid those back taxes and started paying quarterly estimated tax.

Links mentioned in episode

grad student los angeles

0:00 Introduction

0:54 Please Introduce Yourself

Adriana Sperlea is a PhD student at the University of California, Los Angeles. She is studying Bioinformatics through an interdepartmental program. She is an international student from Romania. Her stipend is about $32,500 and she says it goes up a little bit every year. Each month, she receives $2,400. She is in her fifth year of her program.

3:03 How do you live within your means in Los Angeles?

Adriana says that getting outside financial support wasn’t an option for her. Her family doesn’t have the means to provide her financial support. As an international student, she doesn’t qualify for subsidized loans. After her third year of graduate school, she had a summer internship that provided an income on top of her graduate stipend. This is the only extra income she has been able to receive outside of her stipend. Due to regulations on visas, international students cannot work side hustles. It is illegal for international students to be employed outside of the university. Emily says that international students are in a tough financial position because they don’t have access to options to loans or side income that U.S. citizen graduate students can access.

Adriana was on a training grant that required her to do an internship. It was the Biomedical Big Data training grant. She received pay for her internship and continued receiving her graduate student researcher funding. She lived in San Diego for her internship. San Diego is cheaper than Los Angeles, but she still had to pay her portion of rent for the apartment she shared with her partner in Los Angeles.

6:56 What is your approach to budgeting in Los Angeles?

Adriana says that before she created your budget, she had to figure out your housing costs. She lives in graduate student housing, which is subsidized and affordable, but there’s not enough available for all graduate students at UCLA. In Los Angeles, you have to shop around a lot and hustle to make housing costs work with your stipend income. Many people use Craig’s List. Finding housing that costs 30% of your income is not feasible in Los Angeles, but housing that costs 40% of your income could be feasible.

Adriana explains that the subsidized housing at UCLA is available through a lottery system. Those who get into the subsidized housing are allowed to stay for seven or eight years, basically as long as needed to complete the graduate program. The leases are month-to-month, so people move out at any time of the year. Adriana says there isn’t enough available, so she pushes for more student housing. She lives in a junior one bedroom, which costs $1,300 per month. She pays $650 for rent because she shares the one bedroom. It helps lower housing costs to share a one bedroom, but for many people this is not an ideal situation.

Adriana says that housing and transportation are the two big items for the budget. She doesn’t have a car, but she shares one with her fiancé. She says to find affordable housing, you need to spend time looking for uncommon offers, start early, and have patience. You may need to sacrifice certain amenities and quality, but look for places livable and clean. Ultimately, there is only so much you can do.

13:30 What is the system that you use for budgeting?

For her budgeting system, Adriana uses a manual spreadsheet. She inputs her income and monthly fixed payments first. Then she divides the remaining income by four, for four weeks of the month. This sets her variable spending income for each week. Whenever she buys something, she inputs it. She always has a sense of what she spends. She buys groceries on the weekends and cooks her meals, so she doesn’t go out to eat during the week. She doesn’t spend anything Monday through Friday. Often, she has about $100 leftover to use on the weekends for fun.

Emily recaps Adriana’s budgeting system. Adriana subtracts her monthly bills from her monthly income. With the remainder, she divides by four for each week. She uses it for groceries first, then doesn’t spend money during the week. She has wiggle room for miscellaneous and money leftover for the weekend. Adriana adds that if she sees something she wants to buy, she puts it on a list. At the end of the month, she looks at her list and ranks the things she wants. This reduces impulse purchases and formalizes the practice of delayed gratification.

17:30 What do you do about large expenses?

Adriana has a savings account with $2000 to $3000. She has this savings because her rent decreased since she moved into subsidized housing and she received extra income during her internship. She uses this savings account for big expenses that are necessary, and then she gradually fills it back up. She says that before her internship, it was really tough to make big purchases. For example, she didn’t go home to Romania often because she didn’t have enough for flights.

Emily recaps that Adriana got a boost from her summer internship. This helped her get ahead. She repays herself into savings instead of using a credit card. Adriana says she has credit cards for maximizing rewards but she does not spend unless she actually has that money. She has a healthy fear of credit cards.

20:16 Any other comments about your budget or how you make it work in Los Angeles?

Adriana has loosened the reigns on herself. She says she has gotten a sense of it after manually managing her budget for so long. Emily says Adriana has internalized her budget. Her budget is in her mind, so she is less dependent on the spreadsheets. Emily says that if you go to a new city, you get thrown. If there’s a big shift in your life that’s a good time to start carefully tracking again.

22:00 Can you talk about saving for retirement?

Adriana shares that about one year ago, she asked her fiancé’s dad about investing. Her fiancé’s dad talks a lot about investing, so she asked to learn more. He recommended the book A Random Walk Down Wall Street*. Adriana realized that investing is not rocket science and super simple. She thinks there is a weird culture around investing to make it sound more complicated than it is. She says that it’s easy, there’s a low risk way to do it, and during graduate school is the best time to invest. She thought that you have to worry about the market, but she jokes that the best strategy is to forget your password.

[* This is an affiliate link. Thank you for supporting PF for PhDs!]

Adriana uses a Roth IRA. This account pays taxes on her money now. She says this is better because during graduate school, this is the lowest tax bracket that she’ll ever be in. It’s the lowest tax bracket that exists, so this is a good time to invest. She puts $200 in every month. She can budget that now because her rent costs are low. Adriana likes to check in and see she’s accumulated money. Emily writes about investing on her blog and agrees investing is easy.

25:54 Can you tell us the story of your big financial mistake from your second year?

When Adriana started graduate school, she was taxed as an international student. As an undergraduate, she went to college in the U.S. She always had taxes withheld and she never had to worry about taxes. But after Adriana started graduate school, Adriana’s residency status changed from non-resident alien to “resident for tax purposes.” This means the U.S. can tax her like she’s a resident. This tax status changed in June of her first year of graduate school, but it was retroactive for the whole calendar year. She had never heard about this issue from anyone else. In June when her status changed, the IRS refunded her about $3,000 that was originally withheld from her. At the time she didn’t fully understand why she received this money, and she spent it. But when April came and she had to do her taxes, she learned that she owed about $3,000 in taxes. It was pretty scary for her.

Emily says this tax mistake is pretty common. For the first full calendar year that you’re in graduate school on a fellowship-style stipend, you’re supposed to pay quarterly estimated tax. Most people don’t know about this.

30:28 How did you pay the tax balance?

Adriana only had about $1,000 set aside. She feels a bit lucky that she was disputing with the IRS for money that she hadn’t gotten back due to a treaty between Romania and the U.S. that provides for international workers to get their taxes back from first five years from working with non-resident alien status. This dispute got resolved at the same time as her large tax bill. She also applied for a payment plan with the IRS. Anyone can do a payment plan with the IRS if you haven’t done one in past five years and your balance is less than $200,000.

Emily says that many people are intimidated by the IRS, but it sounds like Adriana had a good experience. Adriana says she spent a lot of time on hold. But if you’re a graduate student and you realize you can’t pay your tax bill, the IRS is a place to turn to and get a payment plan with no interest.

34:40 Final Comments

Adriana says budgeting can be tough and time consuming, and a little bit stressful. She says it’s worth it because it’s more stressful to not be able to pay rent. Emily says that it’s better to fess up, face up to reality of the situation, and engage with it. Don’t try to run and hide, because that compounds the problems.

35:18 Conclusion

Investing Strategies to Grow Your Wealth During Your PhD Training

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The most important investment you make during graduate school or your postdoc is in your career. But alongside that primary objective, many PhDs also invest money during their training. By far the top challenge or impediment to investing during graduate school or a postdoc is the low pay, and only a fraction of trainees are financially able and ready to invest. However, investing even a small amount of money on a regular basis throughout graduate school and a postdoc can have an enormous impact on lifetime wealth. The even better news is that the process of investing itself is simpler and easier than you probably think.

investing strategies phd training

 

Many investors, both novice and experienced, fall into the trap of thinking that to maximize their investment outcomes, they should focus on choosing the best investments. In fact, there is no reliable way to pick winning investments. There are only three aspects of your investments that affect your investment outcome that you can control: your savings rate, your investment asset allocation, and the cost of your investments.

This article outlines how to grow your wealth during graduate school by optimizing those three factors and implementing a few other key strategies.

A version of this post was originally published on GradHacker.

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Choose Passive Investments

Empirical studies have borne out time after time that passive investing is a more successful strategy than active investing after costs are factored in. Basically, what that means is that buying a set of investments that is representative of a market sector overall (e.g., the entire stock market) is more successful in the long term than trying to pick winners from that same sector. In trying to beat the market, both professional investors and individual investors consistently fail to even match it.

Passive investing is a far simpler strategy than active investing and much less time-consuming to initiate and maintain because there are plenty of high-quality passive investment products available. To enact a passive investing strategy, buy an index fund or an indexed exchange traded fund (ETF). For example, there are index funds and ETFs that reflect the entire stock market or the S&P 500, among numerous others.

The great bonus here is that passive investing is far more time-efficient than active investing. You don’t have to research individual investments to death; just buy them all!

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Maximize Your Savings Rate

Instead of putting your time and energy into agonizing over your investment choices and trying to optimize them, direct it toward increasing your savings rate into your investments. You can free up more cash flow for your investments by decreasing your expenses or increasing your income.

As simple as that sounds, every grad student knows that both time and money are very tight during this phase of life. If you pursue increasing your income or decreasing your expenses, you must be very selective about how you do so. The following posts discuss both of these strategies in much more detail.

Decreasing your expenses:

Increasing your income:

Increase Your Income

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Pick an Asset Allocation and Stick with It

Your asset allocation is the percentage of your investment that is in each asset class or sub-asset class. The three main asset classes are stocks, bonds, and cash. Your asset allocation should be chosen with respect to your investing goal. For a very long-term goal, such as retirement for someone in her 20s or 30s, a very aggressive asset allocation is appropriate, such as 80-100% stocks. If you are a DIY investor, your brokerage firm can help guide you to an appropriate asset allocation.

Your asset allocation should change as the timeline on your goal grows shorter, but not quickly or dramatically. A common pitfall that investors fall into is trying to time the market by changing their asset allocation, i.e., they pull money from stocks into bonds or cash when they anticipate a stock market drop and then try to find the right time to push it back in. While the theory of selling high and buying low is fine, it’s almost impossible to successfully time the market consistently, even for professionals. Instead, maintain your appropriate asset allocation and ride the market down and up.

Minimize Investing Costs

All investments have costs associated with owning and transacting them. You can think of those costs as directly coming out of your investment returns. Over the course of several decades of investing, these costs can reduce your balance in retirement by hundreds of thousands of dollars!

In fact, costs are one of the big reasons that active investment strategies fail to perform as well as passive investment strategies. While active strategies sometimes do generate higher top-line returns than passive strategies, their higher cost almost always knocks the real return experienced by the investor below than that of passive strategies.

With mutual funds, index funds, and ETFs, the cost of owning the investment is expressed very clearly in its expense ratio (a percentage). A low-cost ETF or index fund will have an expense ratio of a couple tenths of one percent or lower, while a high-cost, actively managed mutual fund will have an expense ratio of one percent or higher. For a passive strategy, look for funds with very low expense ratios.

Watch out as well for fees tacked on top of the expense ratio of the fund you purchased itself; these are often charged by the person or institution managing the account, such as a 401(k) administrator, a financial advisor, or a roboadvisor. Make sure that you have a compelling reason for paying such a fee before signing up for one, because it will come directly out of your returns.

Dollar Cost Average

The strategy of dollar cost averaging (as opposed to irregular lump sum investing) is to invest a set amount of money on a regular basis. If you receive a regular stipend/salary, this translates to investing the same amount of money every pay period, ideally through an automated transfer.

One of the big advantages of dollar cost averaging is that committing to the strategy prevents you from attempting to time the market. When you use your discretion over the timing of your investment schedule, many of us will try to guess whether the market is on an upswing or downswing and shift our buying behavior accordingly. This is rarely a successful strategy, whether it is done haphazardly or very deliberately.

In fact, dollar cost averaging actually guarantees that you “buy low and sell high” in a sense, although you are not selling. Because you invest the same dollar amount every period, when the market is low you buy more shares and when it is high you buy fewer shares.

Use a Roth IRA

If your investing goal is to save for retirement – likely the first investing goal you should set as it is the longest-term – it is a great idea to use a tax-advantaged retirement account. A tax-advantaged retirement account protects your investments from taxes over the decades between your contribution and withdrawal in retirement; paying tax year after year would otherwise eat away at your returns. Therefore, using a tax-advantaged retirement account maximizes your returns, as long as you abide by the restrictions on access that it imposes.

Only very rarely do graduate students have access to a tax-advantaged retirement account through their universities; therefore, an individual retirement arrangement (IRA) is their only option if they are eligible. Some postdocs receive retirement account benefits through their universities and some do not. IRAs are set up independently and managed entirely by the investor. This may sound like a big responsibility, but this freedom of choice means you can pick the optimal investments for you.

IRAs come in two varieties: traditional and Roth. Roth IRAs are generally recommended for current lower-earners with great income growth potential, so they are an excellent fit for graduate students and some postdocs!

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Get Started ASAP

Probably the biggest investing mistake you can make is to procrastinate getting started. On average, the stock market ends two out of every three years higher than it started; if you’re ready to start investing but put it off, more times than not you miss out on earnings that could have gone into your coffer. I frequently speak with PhDs-in-training who stay stuck in investing analysis paralysis for years on end. You can always course correct if you realize you made a poor choice with your investments initially, but you can never recover lost time. So even if you aren’t confident you’re making the perfect investment, just get started!

My Experience with Investing During Graduate School

Investing is one of my favorite subjects on which to teach, write, and coach, and my enthusiasm for the subject is due to the thrilling experience I had with investing during my seven years of PhD training. Starting at $0 in 2007, my husband (also a grad student over the same period) and I together grew our retirement investment portfolio to approximately $75,000 by the time we defended in 2014. The success we experienced is largely attributable to our aggressive and increasing savings rate and the long bull market that started in 2009.

I had an inauspicious start with investing when I first opened and funded my Roth IRA. I didn’t actually purchase the investment I intended to when I opened my account, so my money was going into cash! The really embarrassing part of the story is that I didn’t catch my mistake for over a year. When I finally did, I moved my IRA from that first brokerage firm to one I preferred and made sure that all my money went into my investment of choice, a target date retirement fund.

Deciding that a target date retirement fund was right for me only took a couple hours of research, and as it’s a set-it-and-forget-it strategy I have spent zero time over the last decade-ish maintaining it (though I do regularly check the balance). Instead of spending my time and energy monkeying with my choice of investments, I used them to find ways to add more money to my investments.

When I first started contributing to my Roth IRA in 2007, I saved 10% of my gross income, which was $200/month. After we married and combined finances, my husband and I set a lofty goal to max out two Roth IRAs each year. We used frugal strategies to incrementally reduce our spending to free up more money for investing. (Our top five frugal strategies alone helped us reduce our yearly spending by approximately $6,000.) While we didn’t quite achieve our goal during grad school, we did end with a 17.5% retirement savings rate.

Investing is about far more than just numbers to me. Investing throughout graduate school has not only given my family financial security, but it enabled both my husband and I to pursue our post-PhD dream jobs, even though they are risky and less remunerative in the short term.

I want other early-career PhDs to experience a similar degree of financial freedom as soon as possible in their lives, which is why I am such a proponent of investing even during the incredibly financially challenging graduate and postdoc training periods. If you’d like to go even deeper into this subject matter, sign up for my free 7-day email course on investing for early-career PhDs.

Should a Graduate Student Save for Retirement in a Roth IRA?

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For graduate students with sufficient stipends, investing during graduate school is a fantastic financial goal. Counterintuitively, the long-term goal of funding retirement should be the first or one of the first investing goals any individual has. An Individual Retirement Arrangement (IRA) may be an appropriate vehicle in which to invest during graduate school, when the vast majority of graduate students do not have access to a retirement account at their universities such as a 403(b) or 457. But not all graduate students are eligible to contribute to an IRA, and an IRA is only the best choice for certain investing goals. If a graduate student opens an IRA, she must choose either a Roth or a traditional version.

grad student Roth IRA

A version of this article originally appeared on GradHacker.

What is an IRA?

An IRA protects your investments from being taxed while they are growing. An IRA is not synonymous with certain investments, but rather is an envelope around whatever investments you have chosen. As the name implies, the IRA is intended to be used for retirement savings, and by protecting your investments from taxes over the decades, your investments will grow at their fastest possible rate. Due to the power of compound interest, not having to pay tax on the growth of your investments can make a significant positive impact on their value. Therefore, it is a very good idea to use tax-advantaged retirement accounts to the greatest extent of your ability.

In 2018, the contribution limit for people under the age of 50 is $5,500 per year or your amount of taxable compensation, whichever is lower. You can make contributions to your 2018 IRA until April 15, 2019.

Many brokerage firms require a certain minimum account size that may be too high for a grad student just starting out with saving. If that is the case for your preferred brokerage firm, you can save into a savings account or IRA at another brokerage firm (some waive account size minimums if you set up a monthly auto-transfer) and transfer the money when you reach the minimum.

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Who can contribute to an IRA?

Only taxable compensation (previously known as earned income) can be contributed to an IRA. A graduate student’s stipend is taxable compensation if it is reported on a W-2 at tax time. If a grad student has only fellowship or training grant income during a calendar year (not reported on a W-2) and no outside income, he will not be able to contribute to an IRA for that year. Senators Elizabeth Warren and Mike Lee proposed the Graduate Student Saving Act of 2016, which would include fellowship stipends as taxable compensation for the purposes of IRA contributions, but it was not enacted.

If you are married to a person with taxable compensation, you can contribute to a spousal IRA, again subject to the limit of $5,500 or the amount of taxable compensation. There are income limits as well for IRAs, but they are much higher than grad student stipend levels.

If your stipend is not taxable compensation, you can still save for retirement, though it may not be inside an IRA.

Is a Roth or a traditional IRA better for a graduate student?

There are two versions of IRAs available: Roth and traditional. The first-pass difference between the two types of accounts is when you will pay income tax on the money inside it. While the money in your IRA grows tax-free, you do have to pay income tax either upon the contribution (Roth IRA) or withdrawal (traditional IRA).

Initially, when people decide between the Roth and traditional IRA, they compare the marginal tax rates the taxpayer will be in upon contribution vs. withdrawal. The idea is to opt to pay the tax when they are in the lower marginal tax bracket. You know your marginal tax bracket currently; for graduate students without outside income, it is usually the 15% tax bracket or lower. You do not know what your marginal tax bracket will be during your retirement, as both your income and the tax brackets themselves will change in the intervening decades. However, this educated guess applies to the majority of graduate students: You are currently in a relatively low tax bracket because you are in training and building your career. Later in your life, you expect to have a much higher income and be in a much higher tax bracket. If that assumption holds, the Roth IRA is the more appropriate choice. Virtually every graduate student I’ve spoken with about this has chosen to contribute to a Roth IRA during graduate school.

The Roth IRA has some additional flexibility that the traditional IRA does not that may be attractive for graduate students.

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What are the pros and cons of using a Roth IRA?

As graduate students usually lack access to other tax-advantaged retirement account options, the best practice is to only contribute money to a Roth IRA that you intend to invest for retirement. This is in line with the government’s purpose in creating IRAs. The main con of using any tax-advantaged retirement account is that accessing the funds earlier may trigger an income tax payment and a 10% penalty. However, the Roth IRA is unusually flexible.

As you have already paid income tax on the contributions to your Roth IRA, you can remove them at any time without additional tax or penalty. Five years after opening a Roth IRA, a first-time home buyer can remove up to $10,000 without incurring a penalty.

Because of the Roth IRA’s flexibility, some people use it “off-label” as a general savings vehicle. Others may make contributions even if they are not 100% sure they will preserve the money for retirement. Just be sure to match your investment strategy with your intended use for the money; the type of investments you choose for long-term money should be different than those for mid- or short-term money.

Of course, saving for retirement is not an appropriate goal for every graduate student. If you are currently taking on debt (student loans, personal loans, credit cards), your first priority should be to minimize that debt acquisition or even start to repay it. If you can keep your head above water with your stipend but don’t have any kind of cash savings for emergencies or short-term expenses, saving those funds should be your goal, not investing (yet). Even graduate students whose stipends allow for saving may not want to start investing for the long term if they have other financial priorities and their values don’t align with early wealth-building.

If you are a graduate student with a livable stipend who values financial security or independence, using a Roth IRA for your retirement savings is a wonderful choice. If you don’t have taxable compensation, you can still save for retirement in another vehicle. If you aren’t sure what financial goal you are saving for, using a Roth IRA is an option but saving in a taxable account is almost as beneficial and prevents the different purposes from becoming confused.

Did you save for retirement during graduate school? If so, did you use a Roth IRA?

Everything You Need to Know about Roth IRAs in Graduate School

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As you are no doubt aware, graduate students are clamoring for information on investing for retirement. I’ve observed this during my seminars and it’s been documented by the Council of Graduate Schools’ Financial Education. Graduate students are wondering how to get started saving for retirement during graduate school or want to be prepared to start immediately following graduate school. Roth IRAs are an integral component of preparing for retirement for graduate students. This article covers everything you need to know about Roth IRAs in graduate school: what an IRA is, why you should use one, the differences between traditional and Roth IRAs, the type of income you need to contribute to an IRA, how much to contribute to an IRA, and how to open an IRA.

Roth IRA graduate school

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The information in this article is current as of 2023.

What Is an IRA?

IRA stands for Individual Retirement Arrangement. It is a tax benefit offered by the US federal government to incentivize saving for retirement. Anyone with taxable compensation (or a spouse with taxable compensation) can contribute to an IRA; it is not a benefit offered by your workplace like a 401(k) or 403(b). The contribution limit to an IRA in 2023 is $6,500 ($7,500 for people aged 50 and older) or your amount of taxable compensation, whichever is lower.

An IRA is not synonymous with particular investments; you buy investments inside (or outside) of your IRA. An IRA (and other tax-advantaged retirement accounts like a 401(k) or 403(b)) is like a shield that protects your investments from taxes.

If you invest in a regular taxable investment account, every year that you realize a gain you will pay some tax on the gain. This tax effectively suppresses the growth rate you see on your investments, which saps the power of compound interest. An IRA or other tax-advantaged account maximizes that growth rate by eliminating the tax, which ultimately maximizes the amount of money you have in your investments.

However, this tax-advantaged status comes with a trade-off. The purpose of an IRA is to help Americans save for retirement, so there are restrictions on when and for what purpose you can remove money from your IRA. In limited cases, you can remove money from your IRA without incurring any penalty, but in general you have to wait until you are 59.5 years old.

Why Use an IRA Instead of a Taxable Investment Account?

If you were to save for the long-term into a normal investment account, every year you would pay some tax on the gains you realized in the account. If your account had a great deal of turnover in the course of a year, you would pay your marginal tax rate on the gains (10%, 12%, 22%, etc.) plus whatever state tax would be due. If your account had very little turnover, your tax rate(s) would be lower. If instead your money was in an IRA (or a similar tax-advantaged retirement account like a 401(k) or 403(b)), all the gains would be tax-free.

Taxes on a regular investment account amount to death by a thousand cuts. Every year, a fraction of the growth (if there was growth) is removed through taxes and no longer serves as part of the principal for the growth in a subsequent year. Using a tax-advantaged account like an IRA allows the growth to continue unfettered. Over many decades, the balance in an IRA can be hundreds of thousands of dollars larger than the balance in a taxable account to which the same contributions were made.

Further reading: Taxable vs. Tax-Advantaged Savings

For short- or medium-term investing goals, taxable accounts are appropriate because of the complete accessibility of the money contributed. But for long-term investing goals such as retirement, it is very advantageous to use an IRA or other tax-advantaged retirement account.

Why to Contribute to an IRA during Graduate School

Graduate students have a limited income and plenty of claims on that income. They must first and foremost pay for their basic living expenses, which not all stipends can even cover. If there is any money remaining, the student must choose among upgrading his lifestyle, saving up cash, paying down debt, investing, giving, supporting family members, etc. They may very well have higher priorities than saving for retirement. However, there is a very compelling reason for starting to invest for the long term if possible: the power of compound interest aka the time value of money.

As graduate students are most often in their 20s or 30s, time is currently on their side with respect to investing. Many Americans put off saving for retirement until their peak earning years in their 40s and 50s, but the advantage of starting earlier is that you need to save less money overall to reach the same endpoint. This is the time value of money: the money that you invest today is worth more than the money you invest years from now because the intervening time adds value. Investing even small amounts of money during graduate school can massively add to your wealth in retirement, much more so than large amounts of money saved later on.

The mechanism of the time value of money is the power of compound interest.

In qualitative terms, this is how compound interest works: In year 1, you invest some money and it earns a return (we’ll say a positive return, to keep things simple). In year 2, you invest more money which earns a return, plus your contribution and the return from the previous year also earn a return. In year 3, you invest more money and it earns a return, plus your contributions and earnings from previous years earn a return. Before you know it the increases to your account balance each year are coming more so from the growth your previous contributions than on your current contributions; after decades, most of your account balance will be due to growth rather than your direct contributions.

The power of compound interest is modeled by this equation, which represents exponential growth:

compound interest equation

Using the equation for compound growth, you can get an idea of how much money can grow with a given rate of return and time period. In real investing in the stock market, you will not receive the exact same rate of return each year like clockwork; in some years you will lose money, in others you will see a very high return, and everything in between. But on balance, over long periods of time, the math of compound interest reveals the scale of growth possible with even an irregular return like you would see from the stock market. (Investments that give a regular and guaranteed rate of return, such as bonds and certificates of deposit, are comparatively low-returning and not usually considered appropriate long-term investments for a young person.)

For example, if you invested $250 per month at an 8% average annual rate of return for five years during graduate school, in that time you would contribute $15,000 and your ending balance would be $18,369.21. The growth over that time period is nice but not staggering.

But if you then leave that money alone to continue compounding at 8% per year for 50 years – make no additional contributions – your money grows to a mind-boggling $989,688.35!

That’s an extra one million dollars in retirement that you would not have had if you had not started investing during graduate school!

The numbers above are for illustrative purposes only. It’s still incredibly worthwhile to begin investing during graduate school even at a rate of less than $250/month. Compound interest works the same on any sum of money, whether $5 or $5,000. The point is that investing with time on your side turns small amounts of money into large amounts.

Further reading:

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The Difference between Traditional and Roth IRAs

When you open an IRA, you have the choice between opening a traditional IRA and a Roth IRA. (You can contribute to either/both in the course of a year, but the maximum contribution limit applies to them both together, not each separately.) There are a number of differences between the two types of IRAs, especially when it comes to eligibility and withdrawing money in retirement, but there are two key differences that are most salient for young people who are eligible for both types: when you pay income tax and how to withdraw money without penalty prior to age 59.5.

Further reading:

When You Pay Income Tax

With both types of IRAs, you won’t pay any tax while the money is growing inside the IRA.

With a traditional IRA – unsurprisingly, the first type introduced into the tax code – there is an additional tax incentive upon contribution to the IRA, which is that you exclude the amount you contribute from your taxable income for the year (take a tax deduction). You take a tax deduction on the money you contribute, then your money grows tax-free, and then you pay ordinary income tax on the amounts you withdraw each year in retirement. The traditional IRA is a mechanism of tax deferral.

The Roth IRA is the newer type of IRA (named after the senator who introduced it). The tax break on the Roth IRA is the flip of the one for the traditional IRA. You pay the full income tax due on the contribution you make to the Roth IRA, then your money grows tax-free, and you withdraw it tax-free in retirement.

The key to choosing between a traditional and Roth IRA is to guess when you will pay a lower tax rate: upon contribution or withdrawal.

One way to approach this question is by considering when you will be in a lower marginal tax bracket: now or in retirement? The rationale behind this is that you are going to get the tax break on the last dollars of your income, which are likely to fall in your marginal tax bracket. You know your marginal tax bracket today; most graduate students without outside sources of income fall in the 12% marginal tax bracket or even lower (plus your marginal state tax rate). But you have to guess whether the marginal tax bracket you will fall into in retirement will be higher or lower. In the intervening decades, you will experience personal changes in your income and tax bracket, and there are likely to be legislative changes to the tax code and rates.

This guess is probably easier for graduate students than for the average American. Graduate students can make the reasonable assumption that their current income is much lower than their income will be throughout their careers and likely also in retirement. (Ask yourself: Do you want to be living the same lifestyle in retirement that you are in graduate school or would you like it to be more lavish?) Whatever might happen to the tax code more broadly, confidence that you are in a personal low-income and low-tax bracket period is a strong argument for the Roth IRA over the traditional IRA. I and virtually every graduate student I’ve spoken with about this issue chose the Roth IRA over the traditional IRA during grad school.

However, there are more nuanced arguments that you might consider that are more in favor of the traditional IRA, even for someone in a low tax bracket currently. Such arguments are beyond the scope of this article, but there is plenty of reading material available on the decision between the traditional and Roth IRA for you to dive into if you are interested.

Further reading: Traditional vs. Roth IRA: The Unconventional Wisdom

Penalty-Free Early Withdrawal

One of the big planning/psychological barriers to beginning to save for retirement is the nagging question “What if I turn out to need the money in the near future?” After all, life is unpredictable; sustained loss of income or a very expensive emergency might be just around the corner. Some people find it difficult to put barriers between themselves and their money no matter what degree of cash they may have accessible in an emergency fund or other savings. The prospect of sequestering money that can only be used many decades from now in retirement can be daunting.

The Roth IRA (as opposed to the traditional IRA) helps to alleviate this anxiety. While it is rarely a good idea to take already-contributed money out of an IRA (after all, you are unplugging that money from the power of compound interest), you do have that option with the Roth IRA. Because you have already paid your income tax on your Roth IRA contributions, you can withdraw those contributions at any time without penalty (or additional tax). Certain conditions must be met to withdraw earnings early without penalty or tax. For one example of a qualified distribution, the IRA must be at least five years old and the withdrawal is used to buy a first home (up to $10,000); there are other conditions that create qualified distributions as well.

With a traditional IRA, on the other hand, early withdrawals always result in tax due, and penalties are also assessed if the withdrawal is not qualified.

The Type of Income You Need to Contribute to an IRA

Only “taxable compensation” (formerly “earned income”) can be contributed to an IRA; while IRAs are independent of your workplace, they are not independent of work. For most Americans, this is a non-issue, because they work for their income. For example, they might be employees receiving W-2 income or self-employed; both of these types of income are taxable compensation.

Up through 2019, taxable fellowship income not reported on a W-2 was not considered taxable compensation. Starting in 2020, taxable fellowship income not reported on a W-2 is considered taxable compensation. That means that a graduate student receiving a stipend is eligible to contribute their stipend income to an IRA, whether that stipend is reported on a W-2 or some other form (or not at all)—as long as it is taxable in the US.

If none of your income is taxable in the US because you are a nonresident and benefit from a tax treaty, you don’t have “taxable compensation” and are not eligible to contribute to an IRA.

Further reading:

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How Much to Contribute to an IRA during Graduate School

The right amount of money to contribute to an IRA in a given year of graduate school might be $6,500, $0, or somewhere in between.

Graduate school is an extraordinary time of investment in one’s career, possibly to the exclusion of investing for retirement. While many graduate students are paid stipends that more than cover their living expenses, some graduate students are either not being paid a living wage or have unusually high expenses (e.g., have dependents).

To determine the right amount for you to contribute to an IRA, you must explore your means and your goals.

Means: How does your stipend compare to the local living wage? While the local living wage will not exactly match your expenses in every category, it should give you a sense of the baseline cost of living in your county or metro area. If your stipend is at or above the living wage and you aren’t able to save anything, try to reduce your expenses so you can start to invest or accomplish other financial goals. If your stipend is below the living wage, you may not have the means to start saving or investing right now; getting through graduate school without accumulating debt may be an appropriate financial goal.

Goals: Not all graduate students with discretionary income should jump right into investing. There may be higher-priority financial goals such as paying off high-interest debt or saving cash for emergencies or short-term expenses. But if investing for retirement becomes your top financial goal or a goal you work on concurrently with other goals, it is appropriate to contribute to an IRA.

If a graduate student does have the means to invest and investing is their top financial goal, rules of thumb come back into play. The most common (mainstream) retirement savings rates bandied about in the personal finance community are between 10 and 20% of income (gross or net). I think investing 10% of gross income into a Roth IRA is a great initial goal for a graduate student; it was my retirement savings rate when I started graduate school. It may be one easily reached (especially if you build it into your budget from the beginning) or quite challenging. If it takes you years of budget optimization to reach 10% (or you never do), that’s fine. If you want to go higher than 10%, that’s great too, and you’ll have a wonderful nest egg when you transition out of graduate school. (My husband and I reached a 17.5% savings rate from our gross income by the time we defended, but it took years to raise our savings rate to that point.)

A higher retirement savings rate will help you reach financial independence faster, but you always have to balance that against your quality of life in the present. But if you have the means and aren’t working on a more pressing goal, I do recommend regularly contributing to a Roth IRA during graduate school, even if it’s a small percentage. Getting into the habit of saving for retirement is as valuable as the savings itself; if you save during graduate school, once you have a Real Job you’ll never be able to tell yourself that you “can’t afford to save right now.”

Further reading:

How to Open an IRA

The actual process of opening an IRA is straightforward, but choosing where to open it and what to invest in inside the IRA will take some research and decisions on your part.

Briefly, using index funds (a passive investing strategy) is the most effective, least expensive, and most time-efficient manner of investing. You can buy index funds (e.g., the S&P 500 index fund) or a fund of index funds such as a target date or lifecycle fund at any number of brokerage firms. (Brokerage firms that specialize in trading single stocks, i.e., the ones you probably see the most advertisements for, may not offer index funds.)

When you select a brokerage firm, you need to ensure that: 1) it allows you to open an IRA, 2) it offers the investments you are looking for, 3) it is not too expensive to own the funds, and 4) you can meet the account minimums. Index funds are inherently inexpensive, but there will still be some price differences among brokerage firms. Different firms also set different account size minimums, such as between $1,000 and $3,000, but some waive these minimums if you set up an automatic savings rate into the account.

Further reading: Brokerage and IRA Account Minimums

Once you have selected your brokerage firm and investment, you are ready to open your IRA. You should be able to complete the process online in just a few minutes, and the brokerage firm’s website will guide you through the process. You will be asked for your personal information such as your name, SSN, and address. Once you have the IRA open, transfer in the amount of money you need to open the account and/or set up an automatic savings rate, and choose the investment(s) you want to buy with your money.

Why the Roth IRA Is the Ideal Long-Term Savings Vehicle for a Grad Student

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You’re a graduate student with the means and desire to save for your future. What is the best way to do so? If you have taxable compensation, the Roth IRA is an awesome choice. IRAs confer long-term tax advantages so your money grows at its maximum possible rate. The Roth version of an IRA is very well-suited for people who currently have a lower income than they expect to have in retirement. And if you decide that your goal is not saving for retirement after all, you can still access your money!

Further reading: Even Grad Students Should Have a Roth IRA


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Tax Advantage of the IRA

If you keep your investments in a taxable account, whenever a taxable event occurs (like you sell an investment or receive a dividend) you will have to pay tax. Year after year, those taxes erode the gains in your account. In any given year, this may seem like a nibble, but when you consider that you will stay invested for decades, taxes become quite a big bite.

As a simplified example, compare the account balances of two people who invest $5,000 per year at a 10% rate of return over 40 years. The person whose account is not subject to tax ends with $2,434,259.06. The person who pays a 20% tax on the gains yearly ends with $1,398,905.20, 43% less!

The way to keep from paying tax on the gains in your account is to use a tax-advantaged retirement account. This deal does presume that you will not access your money until retirement (exceptions are below). There are many types of tax-advantaged retirement accounts out there, but they all depend on your workplace offering them to you or you being self-employed. Virtually no universities extend their 403(b) benefits to graduate students. Luckily, there is one tax-advantaged retirement account that is independent of your workplace or self-employment income, which is the IRA (Individual Retirement Arrangement).

The IRA is a wonderful vehicle to invest through. As it is independent, you can open this type of account at just about any brokerage firm and can put just about any type of investment inside of it. The world is your oyster when it comes to investment choice inside an IRA. In 2021, you can contribute up to $6,000 per year to an IRA.

You do need “taxable compensation” to contribute to an IRA. Starting in 2020, non-W-2 fellowship income is considered “compensation” for the purpose of contributing to an IRA. As long as your grad student stipend is taxable (it is for US citizens and residents, but may not be for non-residents covered by a tax treaty), it can be contributed to an IRA.

Further reading: Fellowship Income Is Now Eligible to Be Contributed to an IRA

Pay Tax Now, Not Later with the Roth

Tax-advantaged accounts currently come in two flavors: traditional and Roth. The main difference between the two is when you pay income tax on your money. While your money is inside the IRA, it grows tax-free, as discussed above. But you also get a tax break upon either contribution to or withdrawal from the account.

With a traditional IRA, you take an income tax deduction on the money you contribute to the account and pay ordinary income tax on the distributions you take in retirement. With a Roth IRA, you pay your full income tax on the money you contribute and do not pay income tax on the distributions.

When choosing between the traditional and Roth, the idea is to pay tax when you will be in a lower tax bracket. The typical graduate student has a low income during graduate school but expects a higher income later in life and in retirement. Therefore, the Roth option is the more popular for graduate students.

The Roth promises that you will pay tax on your IRA contribution now at your marginal income tax rate (likely 15% or lower) and never pay tax on that money again, no matter how much your investments grow!

Flexibility for Non-Retirement Goals

I’m an advocate of clearly defining your goals and choosing investments appropriate to your time horizon. For this reason, I think that you should only contribute to an IRA if you intend to use the money in retirement. But the Roth IRA rules allow for some flexibility. If the idea of absolutely not being able to use your investments for anything other than retirement is preventing you from starting to invest, you should know that you can access much of the money in your Roth IRA early should you change your mind about your goal.

Usually, when you pull money out of an IRA early, the distribution is subject to a 10% penalty. However, there are big exception categories for the Roth IRA. You can remove the contributions you made to your Roth IRA at any time without penalty. When it comes to your earnings, your distribution becomes qualified and therefore not penalized if you use it for the purchase of a first home (up to $10,000) or for higher education expenses.

So if you want to invest for the long-term but the idea of absolutely not being able to touch your money until retirement puts you off, rest easy that the Roth IRA is a great option for you. If your financial goals change in the next few years, you do have the ability to use the money in your Roth IRA for something other than retirement.

Between the tax-advantaged status, the option to pay tax now at a low rate and never again, and its flexibility to be used for multiple goals, the Roth IRA is just about a perfect retirement investing vehicle for graduate students! The only thing I would change about it is for the contribution limit to be higher. But grad students with taxable compensation have very good reasons to contribute to a Roth IRA